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AACE DRMP practice questions

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Question 1Decision Management

A project has a 30% probability of earning a $100,000 profit and a 70% probability of incurring a $20,000 loss. What is the expected monetary value of the opportunity?

  1. $0
  2. $16,000 Correct answer.
  3. $30,000
  4. $44,000

Explanation

Expected monetary value is the probability-weighted sum of all outcomes, with losses entered as negative values: 0.30 x $100,000 plus 0.70 x (-$20,000) equals $30,000 minus $14,000, or $16,000. The sign convention is the step most often missed when the outcome set mixes gains and losses.

Question 2Decision Management

In a decision tree, what does a square node represent?

  1. A terminal point that records the payoff of a completed path
  2. A chance event whose outcome is governed by probability
  3. A point where a scope baseline change is approved
  4. A decision point where a choice is made among alternatives Correct answer.

Explanation

Decision tree convention uses squares for decision nodes, circles for chance nodes, and branch ends for terminal payoffs. The shape tells the reader whether the following branches are chosen deliberately or determined by probability.

Question 3Decision Management

What does the expected value of perfect information (EVPI) measure?

  1. The spread between the best and worst outcomes in a decision tree
  2. The maximum amount a decision maker should pay for information that removes uncertainty Correct answer.
  3. The expected monetary value of the alternative that is finally selected
  4. The cost of implementing the most likely risk response

Explanation

EVPI is the difference between the expected value with perfect foresight and the expected value of the best decision made under uncertainty. Because it converts uncertainty into a monetary ceiling, it bounds what any study or test could be worth.

Question 4Decision Management

A decision maker consistently prefers a certain outcome over a gamble that has an equal or higher expected value. This person is best described as:

  1. Risk-indifferent
  2. Risk-averse Correct answer.
  3. Risk-seeking
  4. Risk-neutral

Explanation

Risk attitude is defined by the relationship between the certainty equivalent and the expected value of a gamble. A risk-averse decision maker accepts less than the expected value to avoid variance, which is why diminishing marginal utility characterizes this attitude.

Question 5Decision Management

What is required of the criteria weights in a weighted scoring model used to rank alternatives?

  1. They must be expressed in monetary units to allow summation
  2. They must be distributed equally to every criterion to avoid bias
  3. They must be fixed by the sponsor without stakeholder input
  4. They must sum to 1.0 so composite scores are comparable across alternatives Correct answer.

Explanation

Weights are unitless measures of relative importance and must be normalized so that each alternative's composite score uses the same base. If the weights do not sum to a constant, score differences reflect arithmetic artifacts rather than true preference.

Question 6Decision Management

How does Monte Carlo simulation support decision making?

  1. It replaces expert judgment with historical data
  2. It collapses alternatives into a single deterministic point estimate
  3. It repeatedly samples input distributions to build a probability distribution of outcomes Correct answer.
  4. It removes uncertainty from the cost estimate

Explanation

Simulation draws values from the defined input distributions many times and records the resulting output distribution, so the decision maker sees likelihoods rather than one number. This makes confidence levels and tails visible.

Question 7Decision Management

Anchoring bias affects a project decision when:

  1. Team members defer to the most senior person in the room
  2. Prior expenditures are treated as recoverable in the business case
  3. An initial reference value disproportionately influences subsequent estimates Correct answer.
  4. The team collects only information that confirms an earlier belief

Explanation

Anchoring occurs when the first number or framing encountered, such as a sponsor's budget hint, pulls later independent estimates toward it. Countermeasures include generating estimates before the anchor is revealed and using independent ranges.

Question 8Decision Management

Which practice best supports an unbiased generation of alternatives in a group decision session?

  1. Evaluating each idea immediately as it is raised
  2. Limiting participation to senior stakeholders
  3. Separating idea generation from idea evaluation Correct answer.
  4. Recording only ideas that fit the existing baseline

Explanation

Premature evaluation suppresses candor and drives the group toward the safest familiar option. Separating divergence from convergence lets a wider option set survive long enough to be evaluated on its merits.

Question 9Decision Management

A tornado diagram is used in a decision analysis to:

  1. Show the chronological sequence of decisions and chance events
  2. Rank variables by the magnitude of their individual effect on the outcome Correct answer.
  3. Display the cumulative probability of a cost overrun
  4. Compare the probability of two mutually exclusive outcomes

Explanation

Each bar in a tornado diagram shows the output swing produced when one variable moves across its plausible range while others are held at base values. Bars are sorted by swing size, directing further analysis and data collection to the variables that matter most.

Question 10Decision Management

How does the expected value of sample information (EVSI) relate to the expected value of perfect information (EVPI)?

  1. EVSI reflects imperfect information from a specific study and cannot exceed EVPI Correct answer.
  2. EVSI equals the cost of collecting the sample
  3. EVSI is independent of the reliability of the information source
  4. EVSI always exceeds EVPI because sampling adds precision

Explanation

EVPI assumes a flawless forecast, so it sets the upper bound on the worth of any real information. EVSI values an actual, imperfect study, so it is always at or below EVPI and shrinks as the study's reliability falls.

Question 11Decision Management

In the analytic hierarchy process, the consistency ratio of a pairwise comparison matrix indicates whether:

  1. Judgments are sufficiently coherent, with values above about 0.10 warranting revision Correct answer.
  2. The most important criterion has received the highest weight
  3. The number of criteria in the model is appropriate
  4. The matrix must be rebuilt until the ratio is exactly zero

Explanation

The consistency ratio compares the matrix's inconsistency against what random judgments would produce. A commonly used threshold is 0.10; above it, the pairwise judgments are revisited before the derived weights are trusted.

Question 12Decision Management

Alternative A has a 0.6 probability of yielding $200,000 and a 0.4 probability of yielding $50,000. Alternative B yields a certain $150,000. Which alternative has the higher expected monetary value, and by how much?

  1. Alternative B, by $10,000 Correct answer.
  2. Alternative A, by $10,000
  3. Alternative B, by $40,000
  4. Alternative A, by $40,000

Explanation

Alternative A's EMV is 0.6 x $200,000 plus 0.4 x $50,000, which equals $140,000. Alternative B's certain $150,000 exceeds it by $10,000, so the higher-EMV choice is the certain option.

Question 13Decision Management

A risk-averse organization is deciding on a single large, one-of-a-kind project. Which evaluation approach best reflects its risk attitude?

  1. Applying the same discount rate used for routine capital projects
  2. Comparing utility values or certainty equivalents rather than raw EMV Correct answer.
  3. Ignoring the probability of extreme losses because they are unlikely
  4. Selecting the option with the highest expected monetary value regardless of variance

Explanation

For a unique exposure the organization cannot diversify away, the variance of outcomes matters, not just the mean. Utility functions or a certainty equivalent translate the risk attitude into the comparison so that a high-variance option is properly penalized.

Question 14Decision Management

What is the primary advantage of the Delphi technique for eliciting expert input to a decision?

  1. It reaches a decision in a single round to save time
  2. It requires experts to meet face to face so consensus forms quickly
  3. It removes the need for a facilitator
  4. It preserves anonymity while iterating with controlled feedback, reducing dominance effects Correct answer.

Explanation

Delphi collects anonymous individual responses, summarizes them, and returns the summary for another round until the spread of opinion stabilizes. Anonymity prevents a dominant personality or organizational rank from steering the group, and the controlled feedback corrects individual misperceptions.

Question 15Decision Management

Structuring a decision as a hierarchy of objective, criteria, and alternatives mainly helps to:

  1. Replace the need for stakeholder participation
  2. Make the basis of the decision explicit and traceable to the stated objective Correct answer.
  3. Guarantee that the chosen alternative is optimal
  4. Shorten the analysis by reducing the number of alternatives considered

Explanation

A decision hierarchy forces the team to state what it is trying to achieve and to derive criteria from that objective before scoring alternatives. The resulting audit trail shows why an alternative won, which matters when the decision is later challenged.

Question 16Decision Management

In swing weighting, criteria weights are derived by:

  1. Ranking criteria alphabetically and applying a fixed arithmetic scale
  2. Using each criterion's cost as a share of the total budget
  3. Assigning equal weights to every criterion to eliminate bias
  4. Judging the relative value of moving each criterion from its worst to its best level Correct answer.

Explanation

Swing weighting anchors judgment on a concrete change of performance rather than an abstract importance rating. Stakeholders compare the value of the worst-to-best swing on one criterion against the same swing on another, which yields more defensible trade-off weights.

Question 17Decision Management

Two independent projects each fit within the available budget. Project X has a benefit-cost ratio of 1.4 and costs $5 million; Project Y has a benefit-cost ratio of 2.0 and costs $12 million. Under a strict benefit-cost-ratio ranking rule:

  1. Neither can be ranked without a discount rate
  2. Both rank equally because both exceed 1.0
  3. Y ranks first, although the ratio ignores the absolute size of the investment Correct answer.
  4. X ranks first because it costs less

Explanation

Benefit-cost ratios rank efficiency per dollar committed, so the higher ratio ranks first regardless of total capital. The ratio says nothing about the absolute magnitude of value created, which is why capital-constrained portfolios often need a value-per-constrained-resource view instead.

Question 18Decision Management

How does nominal group technique differ from unstructured brainstorming?

  1. It requires a statistically valid random sample of participants
  2. It forbids voting in order to preserve consensus
  3. It uses silent individual generation followed by round-robin sharing and ranked voting Correct answer.
  4. It relies on a single designated expert to supply the ideas

Explanation

Nominal group technique gives each participant private time to write ideas before any discussion, then collects them in rotation so no one dominates, and finally ranks or votes on them. The silent phase and structured voting are what distinguish it from open brainstorming.

Question 19Decision Management

In reserve planning for decision making, management reserve is typically:

  1. Calculated as a fixed percentage of the planned profit margin
  2. Held outside the cost baseline for unforeseen work and released only with management approval Correct answer.
  3. Allocated to activities by control account managers without further approval
  4. Included in the cost baseline for identified risks that have response plans

Explanation

Management reserve addresses unknown-unknowns, so it sits above the cost baseline and remains under the control of senior management. Contingency reserve, by contrast, sits inside the baseline for known risks with planned responses.

Question 20Decision Management

Why is a decision log maintained throughout the project life cycle valuable?

  1. It documents only the decisions that later turned out well
  2. It is required only when an external audit has been scheduled
  3. It captures the rationale, alternatives, and accountability behind each decision for later review Correct answer.
  4. It replaces the risk register as the record of project uncertainty

Explanation

A decision log records what was decided, by whom, when, on what evidence, and which alternatives were rejected. That record supports gate reviews, audits, and organizational learning, and it protects the team when a decision is second-guessed months later.

Question 21Decision Management

A decision has an EMV of $30,000 with no additional information. A study would raise the expected value of the decision to $38,000 but costs $12,000. What should the team do?

  1. Commission it, since $38,000 exceeds the $30,000 value of deciding without it
  2. Commission it because any positive expected value of sample information justifies the spend
  3. Do not commission it; the $8,000 EVSI is below the $12,000 cost Correct answer.
  4. Treat the team as indifferent, because study costs are sunk once approved

Explanation

The value added by the study is EVSI, here $38,000 minus $30,000, or $8,000. Because that is less than the $12,000 cost, the net value is negative and the study should not be commissioned. The comparison must be net of the cost, not gross.

Question 22Decision Management

Option A yields $200,000 with probability p and loses $100,000 with probability (1 - p). Option B yields a certain $50,000. At what probability p are the two options equivalent in expected monetary value?

  1. 0.75
  2. 0.50 Correct answer.
  3. 0.67
  4. 0.25

Explanation

Set p x $200,000 minus (1 - p) x $100,000 equal to $50,000, giving 300,000p - 100,000 = 50,000, so p = 0.50. This break-even probability is the indifference point below which the certain option is preferred.

Question 23Decision Management

Escalation of commitment is most likely to distort a phase-gate decision when:

  1. An independent reviewer with no project history challenges the business case
  2. Gate criteria were agreed before the meeting and applied consistently
  3. Decision makers own the earlier choice and cite prior spending as a reason to continue Correct answer.
  4. Termination is included among the alternatives and priced alongside continuation

Explanation

Escalation of commitment arises when personal accountability for an earlier decision combines with sunk-cost reasoning, making withdrawal feel like an admission of failure. Debiasing controls include independent reviewers, pre-agreed gate criteria, and routinely pricing termination as an alternative.

Question 24Decision Management

An organization must choose a portfolio of projects under a fixed capital budget, with some projects sharing dependencies. What selection approach is most defensible?

  1. Fund projects in the order in which they were proposed until the budget is exhausted
  2. Select the combination that maximizes total value within the budget and dependencies Correct answer.
  3. Split the capital equally across all candidate projects
  4. Fund only the single project with the largest net present value and defer the rest

Explanation

Under a binding budget, the decision variable is the portfolio, not the individual project. The preferred portfolio is the feasible combination with the greatest total value after interdependencies, mandates, and constraints are taken into account, which may exclude a high-value project that blocks better combinations.

Question 25Decision Management

A decision team has clear objectives, agreed trade-offs, and reliable information, but it considered only two variations of the existing design. Which element of decision quality is weakest?

  1. Clear objectives and explicit trade-offs
  2. Commitment to act on the decision
  3. Reliable, unbiased information
  4. A creative, doable set of alternatives Correct answer.

Explanation

Decision quality requires several elements, one of which is a sufficiently rich and genuinely different set of alternatives. When only variations of the status quo are on the table, the team may optimize within a narrow frame and miss a superior approach, even though objectives and information are sound.

Question 26Decision Management

A well-constructed decision statement should primarily:

  1. List every risk event that could affect the project
  2. Embed the preferred solution so the team can align quickly
  3. Identify the single stakeholder who will approve the budget
  4. Describe the choice to be made without implying a preferred alternative Correct answer.

Explanation

A decision statement defines the scope and boundaries of the choice in neutral terms so that alternatives can be evaluated fairly. Embedding a preferred solution biases the process before analysis begins. Risk lists and budget approval details belong to other governance or risk activities.

Question 27Decision Management

In a multi-criteria decision analysis, the decision criteria are used to:

  1. Establish the standards against which alternatives are compared Correct answer.
  2. Estimate the probability of each risk event
  3. Determine the project's cost baseline
  4. Calculate the discount rate for future cash flows

Explanation

Decision criteria represent the dimensions of value that matter to stakeholders and provide the basis for comparing alternatives. They should be measurable and tied to objectives. Discount rates, risk probabilities, and cost baselines are separate analytical inputs.

Question 28Decision Management

A phase-gate review in a stage-gate decision process is best described as:

  1. A recurring status meeting to update the schedule
  2. A financial audit of incurred costs
  3. A technique for estimating activity durations
  4. A point at which a go, no-go, or hold decision is made before proceeding Correct answer.

Explanation

A phase gate is a formal decision point where evidence is reviewed and a choice is made to proceed, stop, or hold the project. It is distinct from routine progress meetings because it authorizes the next stage of investment. Duration estimating and cost auditing are unrelated activities.

Question 29Decision Management

A decision maker who stops evaluating alternatives once an option meets the minimum acceptable threshold is using:

  1. Optimizing
  2. Satisficing Correct answer.
  3. Expected utility maximization
  4. Maximax

Explanation

Satisficing accepts the first alternative that satisfies a defined sufficiency threshold rather than searching for the best possible option. Optimizing and expected utility maximization continue the search for a superior choice. Maximax is a criterion that selects the alternative with the highest possible payoff.

Question 30Decision Management

Confirmation bias is present when a decision team:

  1. Seeks and weights information that supports its existing preference Correct answer.
  2. Uses a random sample to estimate a probability
  3. Assigns equal weight to all decision criteria
  4. Delays a decision to gather additional data

Explanation

Confirmation bias causes people to search for, interpret, and favor evidence that confirms their prior beliefs. It can distort the evaluation of alternatives and the interpretation of risk data. Delaying for data, equal weighting, and random sampling are not definitions of this bias.

Question 31Decision Management

When deciding whether to continue a project, costs already incurred should be:

  1. Excluded because they cannot be changed by the decision Correct answer.
  2. Included because they affect total project cost
  3. Allocated equally across all remaining alternatives
  4. Treated as a management reserve

Explanation

Sunk costs have already been incurred and cannot be altered by the forward-looking decision, so they should not influence the choice among remaining alternatives. Relevant analysis focuses on future costs and benefits. Allocating them across alternatives or treating them as reserve confuses accounting treatment with decision relevance.

Question 32Decision Management

Clear decision rights in a project governance model primarily ensure that:

  1. Every stakeholder has an equal vote on every decision
  2. The person accountable for a decision is identified before the decision is needed Correct answer.
  3. Decisions are made only by the project manager
  4. All decisions are escalated to the sponsor

Explanation

Decision rights specify who has authority to make a decision and who is accountable for the outcome. Clarifying them in advance reduces delays, ambiguity, and rework. Equal voting, sole project-manager authority, and universal escalation are not general requirements of good governance.

Question 33Decision Management

A symptom of groupthink in a decision meeting is:

  1. A designated member argues the opposite position
  2. The group uses anonymous voting before discussion
  3. Members suppress doubts to preserve apparent consensus Correct answer.
  4. Members openly challenge one another's assumptions

Explanation

Groupthink occurs when pressure for harmony leads members to withhold concerns and avoid challenging the majority view. Open challenge, a devil's advocate role, and anonymous input are techniques that help counter it. Suppressing doubts therefore signals the problem rather than a remedy.

Question 34Decision Management

A decision tree is solved by rolling back from the terminal nodes. At a chance node, the rollback value is:

  1. The sum of all branch payoffs
  2. The probability-weighted average of the branch values Correct answer.
  3. The largest payoff among the branches
  4. The smallest payoff among the branches

Explanation

At a chance node, the rolled-back value is the expected value of the branches, calculated by multiplying each branch value by its probability and summing the results. Decision nodes instead use the maximum or minimum according to the decision maker's objective. Summing branch payoffs without probabilities would ignore their likelihoods.

Question 35Decision Management

In a decision model, one-way sensitivity analysis is most useful for:

  1. Identifying which single input can change the preferred alternative within its plausible range Correct answer.
  2. Calculating the exact probability of every outcome
  3. Eliminating all uncertainty from the model
  4. Replacing expert judgment with historical data

Explanation

One-way sensitivity analysis varies one input at a time to see how the preferred alternative or model output responds. It helps identify the inputs that matter most and the ranges over which a decision remains robust. It does not eliminate uncertainty or prove exact probabilities.

Question 36Decision Management

A decision maker whose utility curve is convex when plotted against monetary outcome is best described as:

  1. Risk neutral
  2. Risk seeking Correct answer.
  3. Risk averse
  4. Unable to compare alternatives

Explanation

A convex utility curve indicates increasing marginal utility for money, which characterizes risk-seeking behavior. A risk-averse decision maker has a concave curve, while a risk-neutral decision maker has a linear curve. The shape of the curve describes attitude toward risk, not an inability to compare alternatives.

Question 37Decision Management

Alternative C is dominated by Alternative D. A rational decision analyst should:

  1. Retain C because it might be stronger on an unmeasured criterion
  2. Remove C from the feasible set as dominated by D Correct answer.
  3. Assign C a higher weight than D to compensate for the difference
  4. Select C because a conservative choice is always preferred

Explanation

A dominated alternative performs at least as poorly as another alternative on every criterion and worse on at least one, so it cannot be preferred under a rational evaluation. Removing it simplifies the comparison and focuses attention on viable options. Retaining or reweighting a dominated option would undermine the logic of the model.

Question 38Decision Management

In a Delphi process, the main purpose of feeding back the distribution of expert responses between rounds is to:

  1. Let experts reconsider their estimates in light of the group's reasoning Correct answer.
  2. Force dissenters to change their answers to match the majority
  3. Reduce the number of experts needed to two
  4. Replace the need for a facilitator

Explanation

Delphi feedback gives experts the chance to see the range of opinions and the reasoning behind them while preserving anonymity. This iterative exchange can improve estimates without coercing conformity. It does not eliminate the facilitator or reduce the panel to two people.

Question 39Decision Management

In nominal group technique, silent written generation of ideas is typically followed by:

  1. A round-robin listing of ideas for the group Correct answer.
  2. A break for individual cost estimating
  3. Immediate voting without discussion
  4. A secret ballot to select the facilitator

Explanation

Nominal group technique begins with individuals writing ideas silently and then shares them through a structured round-robin so that each participant contributes. Discussion and voting usually follow the listing stage. Immediate voting would skip the clarification and combination of ideas that gives the method its value.

Question 40Decision Management

A team rejects a project described as having a 40% chance of failure but accepts the same project described as having a 60% chance of success. This illustrates:

  1. Availability heuristic
  2. Sunk-cost fallacy
  3. Framing effect Correct answer.
  4. Anchoring

Explanation

The two descriptions contain the same probabilistic information, but the gain versus loss wording shifts the decision. This is the framing effect, in which logically equivalent presentations lead to different choices. Anchoring, availability, and sunk cost involve different psychological mechanisms.

Question 41Decision Management

A manager estimates a rare risk as highly likely because a similar event was widely reported last month. This judgment is most influenced by:

  1. The availability heuristic Correct answer.
  2. Expected utility theory
  3. The Delphi method
  4. Regression to the mean

Explanation

The availability heuristic occurs when people judge the frequency or probability of an event by how easily examples can be recalled. Vivid recent reporting makes the event seem more common than it is. Regression to the mean, Delphi, and expected utility theory do not describe this recall-driven distortion.

Question 42Decision Management

In an influence diagram, a chance node represents:

  1. A deterministic constraint
  2. The final objective value only
  3. An uncertain variable that affects outcomes Correct answer.
  4. A decision the team controls

Explanation

An influence diagram uses different node shapes to distinguish decisions, uncertainties, and objectives. A chance node represents a variable whose outcome is uncertain and which influences other nodes. Decision nodes represent controllable choices, and objective or value nodes represent what the decision maker wants to achieve.

Question 43Decision Management

A decision maker who relies on technical data, evaluates many alternatives, and tolerates ambiguity is best described by which decision-making style?

  1. Analytical Correct answer.
  2. Conceptual
  3. Directive
  4. Behavioral

Explanation

The analytical style is characterized by careful examination of data, broad information search, and comfort with complex or ambiguous problems. A directive style favors speed and limited information search, while behavioral and conceptual styles emphasize people and broad vision, respectively.

Question 44Decision Management

In a weighted scoring model, raw criterion scores on different scales must usually be normalized before weighting because:

  1. Normalization ensures each criterion has equal weight
  2. Otherwise criteria measured on larger numeric scales dominate the weighted total Correct answer.
  3. Normalization eliminates the need for subject-matter experts
  4. Weighted totals are only valid for monetary criteria

Explanation

Normalization puts scores on a comparable scale so that a criterion measured in large numbers does not overwhelm one measured in small numbers. Weights then express the intended trade-off rather than an artifact of units. Normalization does not equalize weights or remove the need for expert judgment.

Question 45Decision Management

A team has strong analysis but never clarified which objectives matter most. In decision-quality terms, the weakest element is most likely:

  1. Reliable information
  2. Logical reasoning
  3. Clear values and trade-offs Correct answer.
  4. Appropriate framing

Explanation

Decision quality requires clarity about values and trade-offs so that alternatives can be judged against what matters most. If the team has not clarified objectives and priorities, this element is weak even when the analysis itself is strong. Reliable information and logical reasoning address different elements of decision quality.

Question 46Decision Management

A decision has two alternatives and two states of nature. State S1 has probability 0.3 and state S2 has probability 0.7. Alternative A pays $100,000 in S1 and $40,000 in S2. Alternative B pays $20,000 in S1 and $80,000 in S2. What is the expected value of perfect information?

  1. $24,000 Correct answer.
  2. $62,000
  3. $4,000
  4. $28,000

Explanation

The best expected monetary value without additional information is max($58,000, $62,000) = $62,000. With perfect information, the decision maker would earn $100,000 in S1 and $80,000 in S2, giving an expected value with perfect information of $86,000. The EVPI is $86,000 minus $62,000, or $24,000.

Question 47Decision Management

A project has a prior probability of regulatory approval of 0.40. A consultant report is positive. Historically, a positive report occurs with probability 0.80 when approval will occur and with probability 0.30 when approval will not occur. Given a positive report, what is the posterior probability of approval?

  1. 0.32
  2. 0.80
  3. 0.50
  4. 0.64 Correct answer.

Explanation

Bayes' theorem gives posterior approval = (0.40 × 0.80) / [(0.40 × 0.80) + (0.60 × 0.30)]. The numerator is 0.32 and the denominator is 0.32 + 0.18 = 0.50, so the posterior probability is 0.64. The 0.80 value is the likelihood of a positive report given approval, not the posterior probability.

Question 48Decision Management

A risk-averse decision maker has utility U($0) = 0, U($40,000) = 0.70, and U($100,000) = 1.00. The choice is between a certain $40,000 and a gamble offering $100,000 with probability 0.50 and $0 with probability 0.50. Based on expected utility, which choice is preferred?

  1. Be indifferent because both alternatives have the same expected monetary value
  2. Take the gamble because its expected monetary value is $50,000
  3. Take the certain $40,000 because its utility is higher Correct answer.
  4. Take the gamble because its expected utility is 0.70

Explanation

The gamble's expected utility is 0.50 × 1.00 + 0.50 × 0 = 0.50. The certain $40,000 has utility 0.70, which is greater than 0.50, so the risk-averse decision maker prefers the certain amount. Expected monetary value alone would favor the gamble, but expected utility reflects the decision maker's risk attitude.

Question 49Decision Management

For an additive multi-attribute utility function to be valid, the attributes must generally satisfy:

  1. Equal probability of occurrence
  2. Mutual utility independence Correct answer.
  3. Perfect statistical correlation
  4. Identical measurement scales

Explanation

An additive multi-attribute utility model requires conditions such as mutual utility independence so that preferences over one attribute do not depend on the levels of the others. This allows the overall utility to be expressed as a weighted sum of single-attribute utilities. Correlation, equal probabilities, and identical scales are not the required conditions.

Question 50Decision Management

A firm can build a full plant now for $2 million, yielding $8 million if demand is high (probability 0.5) and $1 million if demand is low (probability 0.5). Alternatively, it can spend $0.5 million on a pilot; if the pilot succeeds (probability 0.6), the firm invests $2 million and receives $8 million, and if the pilot fails it stops. Based on EMV, which course of action is preferred and by how much?

  1. Pilot first, by $3.1 million
  2. Full plant, by $0.6 million
  3. Full plant, by $2.5 million
  4. Pilot first, by $0.6 million Correct answer.

Explanation

The full plant EMV is 0.5 × $8 million + 0.5 × $1 million − $2 million = $2.5 million. The pilot EMV is −$0.5 million + 0.6 × ($8 million − $2 million) = $3.1 million. The pilot is preferred by $3.1 million − $2.5 million = $0.6 million because it preserves the option to stop.